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AS Economics Unit 1: Markets and
Market Failure
Syllabus, Key Terms & Charts
10.1 The Economic Problem
The Nature and Purpose of Economic Activity
The central purpose of economic activity is the production of goods and services to satisfy needs
and wants. They should appreciate that economists take a broad view of production and
consumption activities including, for example, self provided goods and services and the benefits
derived from the natural environment.
Economic Resources
Candidates should understand the economists classification of economic resources into land,
labour, capital and enterprise.
Factors of Production: resources we have available to produce goods and services.
Land: all of the natural physical resources
Labour: the human input into the production process
Capital: investment in capital goods that can then be used to produce
other consumer goods and services
The Economic Objectives of Individuals, Firms and Governments
Understand the normal maximising assumptions upon which traditional economic models are
based.
Command economy: the price mechanism plays little or no active role in the allocation
of resources.
Free market: Prices decide allocation of resources
Mixed economy: A mixture of command and free market systems
Scarcity, Choice, and the Allocation of Resources
Appreciate that the decisions of individuals and organisations are likely to be influenced by both
economic and non-economic considerations. Candidates should know that the environment is
an example of a scarce resource, which is affected by economic decisions.

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Opportunity Cost, the Margin, Trade-offs and Conflicting Objectives
Understand production possibility diagrams and be able to use this basic model to illustrate the
different features of the fundamental economic problem.
Production possibility
frontier (PPF):
is a curve or a boundary which shows the combinations of two or
more goods and services that can be produced whilst using all of
the available factor resources efficiently.
Opportunity cost: measures the cost of any choice in terms of the next best alternative
foregone
Value Judgements, Positive and Normative Statements
Distinguish between positive and normative statements. They should understand how value
judgements influence economic decision-making and policy.
Positive statements: Objective statements that can be tested or rejected by referring to
the available evidence.
Normative statements: express an opinion about what ought to be. They are subjective
statements rather than objective statements
10.2 The Allocation of Resources in Competitive Markets
The Determinants of the Demand for Goods and Services
Candidates should know that the demand curve shows the relationship between price and
quantity demanded, and understand the causes of shifts in the demand curve.
Effective Demand: when a consumers' desire to buy a product is backed up by
an ability to pay for it
Ceteris paribus: all factors are held constant except the price of the product
itself.
The Income Effect: when an increase in real income is used by consumers to buy
more of this product.
The Substitution Effect: When the price of a good falls and consumers switch their
spending from other goods to this product.
Movement along the curve: caused by change in price
Shift in demand: Caused by factors other than price
Joint demand: Two complements goods
Ostentatious consumption: The higher the price the higher the demand

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Price, Income and Cross Elasticities of Demand
Candidates should be able to calculate elasticities of demand and understand the factors that
influence elasticities of demand. They should also understand the relationship between price
elasticity of demand and total revenue.
Price Elasticity of
Demand:
measures the responsiveness of demand for a product following
a change in its own price.
Price Elasticity of
Demand formula:
Percentage change in quantity demanded divided by the
percentage change in price
Price Inelastic: If Ped is between 0 and 1
Price elastic: If Ped is greater than 1
Unit elasticity: If Ped is = 1
Income elasticity of
demand:
measures the relationship between a change in quantity
demanded for good X and a change in real income.
Normal goods: have a positive income elasticity of demand so as consumers’
income rises, so more is demanded at each price level
Inferior goods: have a negative income elasticity of demand. Demand falls as
income rises
Cross price elasticity: measures the responsiveness of demand for good X following a
change in the price of good Y (a related good).
Substitutes: an increase in the price of one good will lead to an increase in
demand for the rival product. Cross price elasticity for two
substitutes will be positive.
Complements: when there is a fall in the price of one complement we expect to
see more of the other complement bought. The cross price
elasticity of demand for two complements is negative

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Price Elasticity of
Demand
Formula
PED= % Change in
Quantity Demanded/%
Change in Price)
Interpret
* If Ped = 0 then
demand is said to be
perfectly inelastic.
* If Ped = < 1 then
demand is inelastic.
* If Ped = 1 then
demand is unit elastic.
* If Ped = >1 then
demand is elastic.
Implications
* When demand is
inelastic – a rise in
price leads to a rise in
total revenue
* When demand is
inelastic – a rise in
price leads to a rise in
total revenue
Income Elasticity of
Demand
Formula
YED= % Change in
Quantity Demanded/%
Change in income
Interpret
* If Normal goods =
positive income
elasticity of demand.
As consumers’ income
rises, so more is
demanded.
* If Inferior goods =
negative income
elasticity of demand.
As consumers’ income
rises, so less is
demanded.
Implications
* Normal goods are
usually necessities and
luxuties
* Inferior goods are
usually staple or low
value goods
Cross Elasticity of
Demand
Formula
CED= % Change in
Quantity Demanded of
good A/% Change in
price of good B
Interpret
* If a substitute good =
positive cross elasticity
of demand.
* If compliment good =
negative cross
elasticity of demand.
Implications
* If you produce a
substitute and
compliment good you
can react to a price
change in the price of
other goods
Price Elasticity of
Supply
Formula
PED= % Change in
Quantity Supplied/%
Change in Price)
Interpret
* If Pes = 0 then
supply is perfectly
inelastic.
* If Pes = <1 then
supply is price inelastic
* If Pes = >1 then
supply is price elastic
Implications
* Government taxation
* Exploiting monopoly
power in a market
* Effects on housing
market
* Effects on energy
and commodity
markets
The Determinants of the Supply of Goods and Services
Candidates should be aware that, other things being equal, higher prices imply higher profits
and that this will provide the incentive to expand production. They should understand the causes
of shifts in the supply curve.
Law of supply: is that as the price of a commodity rises, so producers expand their supply
onto the market
Shift in Supply: Change in factors other than price cause a shift in supply
Price Elasticity of Supply
Candidates should be able to calculate elasticity of supply and understand the factors that
influence elasticity of supply.
Price elasticity of supply: measures the relationship between change in quantity supplied
and a change in price.

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The Determination of Equilibrium Market Prices
Candidates should understand how the interaction of demand and supply determines equilibrium
prices in a market economy.
Equilibrium price: point at which consumer demand meets firms supply
Invisible hand: Adam Smith’s description of the hidden hand of the market which
operates in a competitive market through the pursuit of self-interest to
allocate resources in society’s best interest.
Price mechanism: The means by which decisions taken each day by consumers and
businesses interact to determine the allocation of scarce resources
between competing uses.
Causes of Changes in Equilibrium Market Prices
Candidates should understand the significance of elasticities of demand and supply in
influencing the extent of any fluctuations in market prices.
Applications of Demand and Supply Analysis to Particular Markets
Candidates should be able to apply their knowledge of the basic model of demand and supply to
markets, such as commodity markets, agriculture, health care, housing, sport and leisure.
Oil Price Corn Price House Prices
The Interrelationship Between Markets
Candidates should be aware that changes in a particular market are likely to affect other
markets. They should, for example, be able to explore the impact of the introduction of a new
product and a new supplier in a competitive market. Candidates should understand the
implications of composite demand, derived demand and joint supply.
Composite demand: where goods or services have more than one use so that an increase
in the demand for one product leads to a fall in supply for another.

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Derived demand: The demand for a product X might be strongly linked to the demand
for a related product Y
Joint supply: an increase or decrease in the supply of one good leads to an
increase or decrease in supply of another
How Markets and Prices Allocate Resources
Candidates should understand the rationing, incentive and signaling functions of prices in
allocating resources and co-ordinating the decisions of buyers and sellers in a market economy.
They should also be able to use the economists model of the market mechanism to assess the
effectiveness of markets in allocating resources.
The rationing function: when there is a shortage of a product the price is bid up
Signalling function: market prices will adjust to demonstrate where resources are
required and where they are not.
10.3 Monopoly
Monopolies and The Allocation of Resources
Candidates should understand that monopolies have market power and that the basic model of
monopoly suggests that higher prices, inefficiency and a misallocation of resources may result.
Candidates should understand the potential benefits from monopoly, for example, economies of
scale and possibly more invention and innovation.
Pure monopoly: an industry where this is a single seller.
Working monopoly: any firm with greater than 25% of the industries' total sales.
Oligopoly: characterised by the existence of a few dominant firms
Duopoly: the majority of market sales are taken by two dominant firms.
Barriers to entry: means by which potential competitors are blocked.
10.4 Production and Efficiency
Specialisation, Division of Labour and Exchange
Candidates should understand the benefits of specialisation and why specialisation necessitates
an efficient means of exchanging goods and services.
Production and Productivity

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Candidates should understand the meaning of productivity (including labour productivity) and the
factors that determine productivity.
Short run production: is a period of time when there is at least one fixed factor of input
Long run production: all of the factors of production can change
Labour productivity: Actual rate of output or production per unit of time worked.
Economies of Scale
Candidates should be able to give examples of economies of scale, recognise that they lead to
lower unit costs and may underlie the development of monopolies.
Economies of scale: As business expand their scale of production their long run average
(unit) costs of production fall
Diseconomies of scale: Firms eventually experiencing a rise in long run average costs
Economic Efficiency
Candidates should understand that any point on the production possibility boundary is
productively efficient but that allocative efficiency is only achieved when the goods and services
produced match peopleís needs and preferences.
10.5 Market Failure
Positive and Negative Externalities in Consumption and Production
Candidates should understand that externalities exist when there is a divergence between
private and social costs and that negative externalities are likely to result in over-production.
Externalities: third party effects arising from production and consumption of goods
and services for which no appropriate compensation is paid
Negative externalities: when production and/or consumption impose external costs on third
parties outside of the market for which no appropriate compensation
is paid.
Positive externalities: the production and/or consumption of a good or a service creates
external benefits which boost social welfare.
Social Cost: Private Cost + External Cost
Social Benefit: Private Benefit + External Benefit
Public Goods Candidates should understand that public goods are non-rival and non-
excludable and recognise the significance of these characteristics. Candidates should
understand the difference between a public good and a private good.
Private good: Good that is excludable and rival
Public good: A good that is non-rivralrous (your consuming it does not prevent me
consuming it) and non-exclusive (there is no way of preventing you from
consuming it).
Quasi-Public good A good is a near-public good i.e. it has many but not all the
characteristics of a public good
Merit and Demerit Goods
Candidates should understand that the classification of merit and demerit goods depends upon

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a value judgement and that such products may also be subject to externalities.
Merit good: goods and services that the government feels that people will under-
consume and possibly be under-provided.
Demerit goods: Those that cause negative externalities
Market Imperfections
Candidates should understand that the existence of monopolies, the immobility of factors of
production and imperfect knowledge are likely to result in a misallocation of resources.
Pure monopoly an industry with a single seller
Near/Working monopoly any firm with greater than 25% of the industries' total sales
Oligopolistic industry: existence of a few dominant firms
Duopoly: the majority of market sales are taken by two dominant firms.
Cartel A group of producers who enter a collusive agreement to restrict
output in order to raise prices and profits.
Inequalities in the Distribution of Income and Wealth
Candidates should understand that, in a market economy, an individuals ability to consume
goods and services depends upon his/her income and wealth and that an unequal distribution of
income and wealth may result in an unsatisfactory allocation of resources.
10.6 Government Intervention in the Market
Rationale for Government Intervention
Candidates should understand the reasons for government intervention in a market economy.
Methods of Government Intervention to Correct Distortions in Individual Markets
Candidates should be able to use basic economic models to analyse and evaluate the use of
indirect taxation, subsidies, price controls, buffer stocks, pollution permits, state provision and
regulation to correct market failure.
Indirect taxation: tax, such as value added tax, that is levied on goods or services rather
than individuals
Subsidies: Money given by government to lower prices or increase supply

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Maximum price: legally imposed price in a market that suppliers cannot exceed – in an
attempt to prevent the market price from rising above a certain level.
Minimum price: A minimum price is a legally imposed price floor below which the normal
market price cannot fall.
Buffer stock: schemes that seek to stabilize the market price of agricultural products by
buying up supplies of the product when harvests are plentiful and selling
stocks of the product onto the market when supplies are low.
Pollution Permits: rights to sell and buy actual or potential pollution in artificially created
markets.
Government Failure Candidates should appreciate that government intervention does not

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necessarily result in an improvement in economic welfare. Governments may create rather than
remove market distortions. Inadequate information, conflicting objectives and administrative
costs should be recognised as possible sources of government failure.
Government failure: intervention distorts markets still further leading to a further loss of
allocative efficiency
The Impact of Government Intervention on Market Outcomes
Candidates should be able to apply economic models to assess the role of markets and the
government in areas such as health care, housing, agriculture and the CAP, transport and the
environment.